Drivers of food price run-up continue

Despite “remarkable course changes” in the food-versus-fuel debate that occurred in 2008 when oil and many agricultural prices reached record levels, “the key drivers of food prices and their complex interactions remain the same now,” according to a new report from the Farm Foundation.

The new study by Purdue University economists Phil Abbott, Chris Hurt, and Wally Tyner, updates the July 2008 report, “What’s Driving Food Prices”. That report attributed the sharp rise in consumer food prices to three major forces then occurring:

• World agricultural commodity consumption exceeding production growth, leading to very low commodity inventories.

• The decline in the value of the U.S. dollar.

• The new linkage between energy and agricultural markets.

In the second half of 2008, each of these forces reversed direction, the economists note.

“The world financial crisis put the brakes on world income growth; global crop production returned to more favorable levels for both 2007-08 and 2008-09 crops; and after July 2008, the exchange rate of the U.S. dollar appreciated against major currencies.

In spite of the “truly remarkable, almost 180-degree course change, these key drivers remain the same, says Tyner.

“Our updated analysis verified the role of these drivers — although they sometimes play out in different ways.”

Although grain/oilseed prices have dropped sharply, he notes, they remain “well above long term norms.

“Commodity market prices have declined more rapidly than production costs, yielding tight margins for producers. In the future, agricultural commodity prices will depend greatly on exchange rates and crude oil prices, which in turn are linked to macroeconomic performance.”

Macroeconomic forces such as global recession and financial crisis “generate higher unpredictability,” Tyner says, and the impact of these forces has been more quickly reflected in the value of the dollar, crude oil prices, and agricultural commodity prices, than have changes in supply and utilization.

Since last July, he says, the dollar has appreciated against the Euro and many other currencies, especially those of developing countries, leading to weaker exports and more imports. Appreciation of the dollar also has contributed to rapid declines in the dollar price of ag commodities.

As biofuels production has surged since 2006, “energy and agricultural markets have become closely linked,” Tyner says. “Ethanol and biodiesel were linked as energy substitutes for gasoline and diesel, and usage of crops for these biofuels became large enough to influence world prices.”

In the last half of 2008, Tyner notes, crude oil prices fell rapidly, but gasoline prices “fell faster and further. Low gasoline and crude oil prices reduced the expected use of corn for ethanol which, in turn, put pressure on ethanol and corn prices. By the end of 2008, the ethanol industry’s economic fortunes had deteriorated such that up to 2 billion gallons of capacity was idled.

“There have been changes in the way markets are now functioning, but the basic relationship between crude oil and corn remains strong.”

Whether the future takes prices up or down will depend on “many unknowns,” Tyner says, not the least of which are “the depth and recovery characteristics of the current global financial crisis and recession.

“Other unknowns include the potential for inflation and its possible influence on commodity prices, the direction of the U.S. dollar exchange rate, and the price of crude oil and agricultural commodities.”

Market-specific supply and utilization events will continue to drive prices for individual commodities around these macroeconomic and energy market trends, the report notes.

“Persistent, large demand for corn and oilseeds to produce biofuels led many to predict that this period of high food prices would last longer than earlier episodes. As global economies recover, the potential exists for increased demand for feed.

“Given the lags in adjustments of input costs, the big supply/use questions are: When will supply responses catch up to increasing demand? Will declining real agricultural prices return? Will these new circumstances lead to higher agricultural commodity prices in the future? How will agricultural and energy policies influence future commodity prices?”

Understanding the function of these driving forces that affect food prices “is critical in helping public and private leaders to make informed decisions about business strategies and public policy,” says Farm Foundation President Neil Conklin. The update of the 2008 report continues the organization’s effort to provide “a comprehensive, objective assessment of the forces driving food prices,” he says.

Following release of the Farm Foundation report, the National Corn Growers Association announced a competition, organized by the foundation, to “seek innovative and promising public policy options to address the challenges agriculture may face in providing food, feed, fiber, and fuel during the next 30 years.”

NCGA President Bob Dickey said, “Our country and the international community face a number of opportunities and challenges in the years ahead, and we believe there are ways we can help address these by producing more corn for food and energy.”